Rhetorical Q&A On The Future Of QE2 With Goldman's Jan Hatzius

Tyler Durden's picture

Goldman's Jan Hatzius, who after flipping his view on the economy in early August, and taking all of the street with him, has recently flopped back to a semi-optimistic outlook. What is amusing is that despite his suddenly far more bullish outlook, he, as well as the entire Goldman team, continue to call for $2 trillion in total QE2. Of course the two are completely at odds with each other, but hey - if it means 2011 will be another record bonus year, why leave something as irrelevant as logic stand in the way of that 3rd French Polynesian island. On the other hand, Hatzius is certainly not stupid, so in continuing with his rhetorical device of an hypothetical interrogation, today Hatzius releases his latest Q&A, this time focusing on the future of Quantitative Easing. What is most notable, is that as of today, the Dutch strategist sees the possibility for less QE2 post June, contrary to his recent missives which expected QE2 to continue until the full $2 trillion of expected monetary base "printing" was fulfilled. Then again, as Ireland has so aptly demonstrated today, at this point it is no longer a question of whether any economic policy is viable in the long-run. All that matters is for putting enough lipstick on the bankrupt global pig for another few months at a time, so that yet another sovereign constituency can foot the bills in what has become a rolling global bailout of country after country.

As for the Q&A - if at this point there is still anyone who is confused about what printing trillions of monetary base units means, then by all means read the attached.

Hatzius' summary:

  • Today’s focus article looks at the future of the Fed’s quantitative easing program (QE2)—or large-scale asset purchases (LSAPs) in the Fed’s preferred terminology—after the recent backlash at home and abroad.
  • In our view, the anxiety about the inflationary consequences of QE2 is misplaced.  The reason is that the US economy and financial system is not well described by the simple “money multiplier” model, in which increased bank reserves automatically result in an inflationary lending boom.  In particular, deposits subject to reserve requirements are much less central to the financing of US banks than assumed in this model.
  • Instead, it is better to think of QE2 as a swap of cash for Treasuries on the asset side of the private sector balance sheet.  This swap should lower the bond term premium and thereby boost growth, at least to some degree, but it does not automatically lead to a large expansion in broader money and credit aggregates.  Even if it did, the first effect in an economy operating with as much slack as the US economy currently has would probably be to boost output rather than prices.
  • Our central estimate is that QE2 is likely to boost real GDP by about ½% per $1 trillion (trn).  While that is not a very large number, we believe that the benefits exceed the costs, at least so long as the political backlash does not restrict the Fed’s operational independence.
  • However, the backlash probably does increase the hurdle for additional purchases beyond the $600 billion (bn) planned through June.  Combined with the better data of recent weeks, it has increased the risk that Fed officials will ultimately stop short of our estimate of $2 trillion (trn) in cumulative QE2.

And the complete Q&A:

Where do we stand after all the criticism of the Fed’s decision and the renewed tightening in financial conditions?

Q: First of all, why do you keep calling it quantitative easing (QE2) when Ben Bernanke himself takes exception to the term?
A: Inertia, really.  We fully agree with Bernanke that the impact of large-scale asset purchases (LSAPs) occurs almost exclusively via the asset side of the Fed’s balance sheet—in particular, through the effects of its purchases on asset prices—rather than through the liability side (i.e. the quantity of reserves), as discussed below.  But at this point it seems somewhat pointless to keep fighting this terminological battle.

Q: How does QE2 work???
A: The mechanics of QE2 are shown in Exhibit 1.  Fed officials will buy $600 billion (bn) of longer-term Treasury securities and create $600bn in additional bank reserves in exchange.  This increases the Fed’s balance sheet as well as the so-called monetary base (currency plus bank reserves) by $600bn.

Q: So are Fed officials “printing money”?
A: If “money” is defined as the monetary base, the answer is yes.  Each $1 in LSAPs will result in an additional $1 in bank reserves.  However, if “money” is defined as one of the broader money or credit aggregates—which matter much more for economic activity and inflation—the answer is not necessarily.  Unless banks decide to leverage the extra reserves by increasing lending, QE2 is simply a shift of assets held outside the Fed from longer-term Treasuries to cash and bank reserves.

Q: If that’s all it is, why the worry that QE2 will cause much higher inflation?
A: The concern is that the increase in bank reserves will cause a sharp increase in bank lending, which in turn will boost demand and ultimately prices to an excessive degree.  It is based on the traditional “money multiplier” theory, which holds that the availability of bank reserves is the key constraint on the amount of bank lending.  When the Fed adds reserves to the system, the story goes, banks scramble to make more loans until these “excess” reserves have been turned into required reserves that are needed to support the higher level of bank loans.  The supposed explosion in credit then leads to an unsustainable boom in demand and ultimately inflation.

However, we believe that the money multiplier model is a very poor guide in the US financial system.   It stands and falls with the assumption that deposits subject to reserve requirement are the only source of bank funding, when in fact more than 90% of bank funding comes from other sources (including many deposits on which reserves are not required).  Thus, bank lending was not constrained by the availability of reserves even prior to the increase in bank reserves.  Relieving a non-existent constraint cannot be expansionary, and it cannot be inflationary.  Hence, the standard story for how QE will result in inflation is incorrect, in our view.

Q: Are you saying that QE2 has no effect on lending, output, and inflation?  If so, why do it?
A: It does have an effect, but it works through a different channel.  The shift in the composition of the private sector’s asset holdings from longer-term Treasuries to cash should raise the price (lower the yield) of longer-term Treasuries.  A lower Treasury yield should feed into a reduced discount rate and therefore a higher price of risky assets, and it may also weaken the US dollar.  In turn, easier financial conditions—i.e. lower long-term interest rates, higher stock prices, and a weaker dollar—should boost economic activity.

Stronger economic activity will also deliver a (small) boost to inflation.  In addition, there is likely to be—in fact, there has already been—a positive effect on inflation expectations.  So we do think that there is a link between the Fed’s actions and future inflation.  It is just far less dramatic than in the typical “printing money” story, and much farther off in the future.

Q: If the effect is supposed to occur via lower long-term interest rates, why have Treasury yields in fact risen—and financial conditions tightened—since the QE2 announcement?
A: Probably mainly because the market has actually reduced its expectation of the cumulative amount of QE2.  While the cumulative purchase announcement of $600bn itself was modestly ahead of market expectations, the somewhat slower-than-expected pace of purchases, the backlash against the decision at home and abroad, and the better economic data of recent weeks have created a lot more doubt whether Fed officials will buy more assets beyond June 2011.

That said, Treasury yields are still somewhat lower—and more importantly financial conditions are still significantly easier—than they were before the expectation that Fed officials would buy anew.  As of Friday’s close, our Goldman Sachs Financial Conditions Index (GSFCI) stood at 97.48, about 50bp easier than the level seen in August when the market began to shift to an expectation of QE2.

Q: How big is the boost to growth?
A: That’s a hard question to answer, but our best estimate is about ½ percentage point of additional GDP growth per $1trn in LSAPs.  Part of the reason why it is so uncertain is that the precise number depends on three separate estimates:

1. The sensitivity of the term premium to Fed purchases;

2. The sensitivity of financial conditions to the term premium; and

3. The sensitivity of GDP growth to financial conditions.

All of these variables are measured with considerable error, but our estimates are as follows:

1. A $1trn asset purchase lowers the term premium by around 30bp.

2. A 30bp drop in the term premium eases financial conditions as measured by our GSFCI by about 80bp.

3. An 80bp easing in the GSFCI normally raises real GDP growth by ¾ percentage point in the first year; however, given how clogged the housing channel is at present, we believe a more realistic figure may be ½ percentage point.

Q: Why do QE2 if its effect is so small?
A: For one thing, it’s not that small in absolute terms.  An extra ½% of GDP amounts to $75bn per year and perhaps corresponds to an extra 400,000 jobs.  That’s not a lot relative to nearly 15 million unemployed workers, but it’s a start.

Moreover, monetary policy decisions always boil down to a cost-benefit calculation at the margin.  The main perceived cost of QE2—or indeed any monetary easing decision—is a higher long-term risk of actual and expected inflation in excess of the Fed’s 2% target.   But while the risk of inflation does rise at least a bit with QE2, we need to set against this a reduced risk of deflation.  Since deflation is probably the greater risk at present, the perceived cost is, on net, actually likely to be an additional benefit.

Q: Are there any other potential costs?
A: The most obvious cost is the political risk, including the possibility that Congress will curtail the Fed’s independence and ability to deal with future crises.  That is not our expectation, but it is not impossible either.

Another concern is that lower long-term interest rates may increase commodity prices, which would weigh on growth for a net commodity importer such as the United States.  This could weaken—or in an extreme case even reverse—the positive impact of QE2 on growth.  It is again difficult to assess the magnitude of this effect.  However, we can glean some information from a 1999 Federal Reserve paper describing the impact of different shocks in the staff’s model of the US economy, FRB/US.  It suggests that a $10/barrel increase in oil prices lowers GDP growth over the next year by 0.2 percentage point.   If so, it would take roughly a $25/barrel increase—a much bigger move than the $5-$10 increase seen in the runup to QE2—to offset the GDP effects of QE2.

Finally, there is some risk to the Fed’s prestige if QE2 isn’t followed by a visible improvement in the economy and the labor market.   The best analogy is the stimulus package of early 2009.  Although we (and most other economists) believe this helped the economy in 2009-2010, the effect was not large enough to overcome the underlying weakness.  The package thus probably helped discredit activist fiscal policies in the eyes of many Americans.  The problem is that it is difficult to distinguish between the “baseline”—the path of economic growth and employment in the absence of the stimulus—and the impact of the stimulus itself.
The Fed is running some risk of a similar outcome with QE2.  If the recovery continues to disappoint, QE2 will undoubtedly be viewed as a failure, even if it in fact helped matters at the margin.  However, the difficulty of distinguishing between the “baseline” performance of the economy and the effects of QE2 cuts both ways.  If growth picks up, the Fed would likely receive part of the credit, even if the improvement occurs because the private-sector deleveraging process slows, or because of other non-monetary factors.

Q: So how close is the private sector to stronger, self-sustaining growth?
A:  It is very difficult to have a confident view of timing, even though the qualitative economics of the situation is quite clear.   Because the private sector is trying to pay down debt, its financial balance—i.e., the gap between its total income and total spending—has risen to a level that needs to be offset by larger government deficits than the public is willing to tolerate over anything but the very short term.  This means that the economy as a whole suffers from insufficient aggregate demand during the private-sector deleveraging episode; in effect, the different sectors of the economy, when taken together, are “trying” to spend less than they earn, which is a recipe for economic weakness.

Once the private deleveraging has progressed sufficiently, the private-sector balance will fall and this will result in a boost to aggregate demand growth.  At present, Exhibit 2 shows that the private sector balance currently stands at +7% of GDP, which is about 5 percentage points above the long-term average.  A full return to the long-term average would be the equivalent of an exceptionally powerful fiscal stimulus program, but even a partial return would be quite helpful.

The key condition for a drop in the private sector balance is a sufficient decline in the level of private-sector debt.  Unfortunately, however, nobody has come up with a good model of what constitutes a “sufficient” decline.  In the absence of such a model, we can perform simple “what if” calculations that assume a return of the debt/income ratio to a more or less arbitrary benchmark, or we can evaluate the experience of other countries that have gone through deleveraging cycles.  In general, this type of analysis suggests that the process still has a ways to go, i.e. that the private sector balance will stay high for another couple of years.   But given the lack of a clear benchmark for what constitutes an acceptable debt level as well as the significant differences between the deleveraging experiences across countries, it is quite a tentative conclusion.

Q: In the private sector deleveraging story you just told, there is not much room for monetary policy.  Isn’t that in itself a statement that QE2 is unlikely to have a big effect?
A: Yes, it is.  We believe that in a balance sheet recession, monetary policy is inherently less powerful than fiscal policy because the private sector’s attempt to reduce its leverage works at cross-purposes with lower interest rates.  That doesn’t mean that the effect is zero, because the pace of the deleveraging is likely to depend at least partly on interest rates and broader financial conditions.

In any case, however, it is better to think of QE2 as a type of “holding operation” that reduces the likelihood of deflation, which would make it yet more difficult for the private sector to reduce the real value of its nominal debt burden.  QE2 is unlikely to turn the economy around, even though it probably does help at the margin.

Q: You have argued that the Fed may end up buying as much as $2trn.  How confident are you in this estimate?
A: Frankly, not that confident.  This is partly due to the inherent uncertainty in the economic outlook.  Although we believe that the economy will still be fairly sluggish in coming quarters, the recent data have been a bit firmer than expected and faster growth is possible.  This is important because our calculations for how much QE is “warranted” are quite sensitive to the economic inputs, i.e. the inflation and unemployment forecast one year ahead.

In addition, the backlash against the Fed’s policy probably does raise the hurdle for substantial further purchases beyond June.  In our analysis of the potential cumulative volume of QE2, we assumed that the Fed views purchases of assets as significantly more “costly” than an equivalent amount of short-term interest rate cuts.  These costs include economic factors such as the tail risk of a significant increase in inflation expectations and/or the greater difficulty of exiting from the current highly accommodative policy stance.  But they also include political factors such as an increased risk that Congress will curtail the Fed’s independence in response to continued QE.  At the margin, this is likely to reduce the committee’s appetite for further QE beyond June.

Q: Is it possible that the committee will in fact decide to stop the purchases before they reach $600bn?
A: That is highly unlikely.  Although the committee promised to review the policy regularly, we believe that the hurdle for actually stopping the purchases is very high.  The only realistic scenario, in our view, would be a very substantial increase in inflation expectations to a level clearly above the recent norm.  Otherwise, Fed officials would almost certainly complete the $600bn program.

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Atomizer's picture
Strauss-Kahn on Europe's growth Challenges


The above circle jerk speaks

Soul Coughing - How Many Cans? To Kick?



snowball777's picture

"...the check fat off of my slenderness."

Love that Doughty.


99er's picture

Why Wait Until 7 December?

Ireland's biggest banks are facing collapse this week unless an immediate international bail-out package can be agreed, senior insiders have revealed.

Allied Irish Banks and Bank of Ireland have each suffered a multibillion-euro ‘run’ as foreign investors withdraw their cash amid fears that both institutions are effectively bust.

Read more: http://www.dailymail.co.uk/news/article-1331690/Ireland-bailout-Banks-brink-collapse.html#ixzz15wgFdiSc

Dapper Dan's picture

Thousands of French protesters have taken up the former Man United footballer's call for a mass cash withdrawal.

As students and public sector workers across Europe prepare for a winter of protests, they have been offered advice from the archetypal football rebel Eric Cantona,  the now retired Cantona is urging a more sophisticated approach to dissent.

The 44-year-old former footballer recommended a run on the cash reserves of the world's banks during a newspaper interview that was also filmed. The interview has become a YouTube hit and has spawned a new political movement.

Cantona's call appeared to touch a popular chord and generated an instant response. Nearly 40,000 people have clicked on the YouTube clip, and a French-based movement – StopBanque – has taken up the campaign for a massive coordinated withdrawal of money from banks on 7 December. It is claimed that more than 14,000 people are already committed to removing deposits. The movement is also gaining increasing attention in Britain.


Ripped fromhttp://www.guardian.co.uk/world/2010/nov/20/eric-cantona-bank-protest-ca...

LeBalance's picture

Under the question of "inflation concerns" confidence was not mentioned.  Hopefully, these folks "get" the concept of money printing == monetary inflation, that's level 1.  But it is very important to look at the quality of the money base as it is being drastically degraded.  Not only is it being increased, it is being built with LSAPs that are toxic.

This is a classic recipe for a "snap" in the confidence rubber band. (h/t FOFOA).  This instantaneous event, the "snap" in confidence, is the hyperinflation "Black Swan."  It is a foregone conclusion that no one will want to hold a currency (eg. $) whose backing is such dreck.

So inflation in the first level is money printing, sure.  But deep in the dark basement of the Fed, lurks inflation's dark shadow.  That shadow is realized when confidence evaporates and it is hyperinflation.

So you CAN have both deflation, inflation, and hyperinflation.  Let's say deflation in tha total value of real estate property values, inflation in overall monetary supply (consumer plus government) and then hyperinflation (caused by a lack of confidence and an exodus from a particular currency).

The social impact planet wide is being felt now, but what is coming is unimaginable.

:) LB

ZeroPower's picture

Indeed. Deflation now, inflation is the near future, and hyper inflation coming (in theory, only).

Why we will never get to hyper inflation is because these LSAPs will stop well before employment is at its norm. Unless we reach the NAIRU anytime soon (we won't, we = usa), there is very very slim risk of this QE being hyper inflationary.

Does the gov manipulate CPI figures? Is the fed printing away its troubles? Sure. But there is literally no other better option right now.

Lets just hope it doesn't get to $2Trn until QEx.

doolittlegeorge's picture

first off "the cartoon variant was much better."  Second "since Goldman is being paid to run our Treasury" they're "being paid to be right."  Are they? Or "are they as wrong as..."  If it's the latter "precisely what skin do they have in this fight institutionally?"  Given Lloyd Blankfein's testimony before the our Represtantives in DC this Spring--seems like years ago now- ("see this dollar sign on my left butt cheek mo fo?  why don't YOU just...") i'd say HE'D say "not one friggin' cent!"  Which "leads us to number three."  Why are we listening to them when they don't give good investment advice and "in fact give intentionally bad advice when they feel it suits their interests" as "per their testimony before the United States Congress"?  Which "leaves us with question number 4" and the only one that matters and all you should have asked:  "how are you not phucking us right now?"  Or perhaps even better "as you phuck us right now precisely how are you doing it because I want in on it."  Needless to say if you were to ask "The Goldman Sachs" what they're business policy on "bailing out clients is" I think you'd get a "slight variation from the way they look at government bailouts."  In short "at what point does our entire Treasury Department start looking for an exit strategy...and to where exactly."

Amish Hacker's picture

"The shift in the composition of the private sector’s asset holdings from longer-term Treasuries to cash should raise the price (lower the yield) of longer-term Treasuries. "

What am I missing here? Seems like if everyone sells the 30-year and goes to cash, then the 30-year goes down in price (i.e. yields increase). 

ZeroPower's picture

The Fed wants depressed treasuries (as you note, high Px low yield). As the private sector is selling their USTs, the Fed is buying them up - with both hands and feet. Note so far QE2 purchases (officially anyway) are for the medium term treasuries - not too far out on the curve (30s should be dropping).

Amish Hacker's picture

Thanks, ZP. I see your point, but it makes me even Q-wheezier to think about it. His statement could be rephrased as, "We are going to keep interest rates low by transferring ownership of longer-term treasuries from private hands to the public balance sheet. This will be great for the economy."

This won't end well.

Thomas's picture

Sorry. Couldn't stomach it after awhile and am still going to comment--a cardinal sin under most circumstances, so I'll keep it short: What a sack of shit. Lies. You Goldman guys--I know you are reading this--should be hung from the necks until dead. We could have a trial later if need be. Bite me.

Sorry. I am normally civil, but this PR blitzkrieg has got me a little edgy. You get Ben's op ed. Then you get Blinder's op ed. Now you get this unadulterated bullshit.

treemagnet's picture

Couldn't agree with you more. 

Mark Medinnus's picture

Ditto, my ass. The correct reply is f*ckin a 

etrader's picture

 "the Dutch strategist"

Thought  Hatzius was from Deutschland.....?

curious1's picture
New large species of squid found

Squid of this type have light-producing organs to attract prey....

A new species of squid has been discovered by scientists during a research cruise in the southern Indian ocean.

The 70cm-long specimen is a large member of the chiroteuthid family.

Squid from this group are long and slender with light-producing organs, which act as lures to attract prey.

It was found during analysis of 7,000 samples gathered during last year's Seamounts cruise led by the conservation group IUCN.

The project started a year ago when marine experts embarked on a six-week research expedition in the Indian Ocean.

The aim of the cruise was to unveil the mysteries of seamounts - underwater mountains - in the southern Indian Ocean and to help improve conservation and management of marine resources in the area.

"For 10 days now 21 scientists armed with microscopes have been working through intimidating rows of jars containing fishes, squids, zooplankton and other interesting creatures," says Alex Rogers, of the Department of Zoology at the University of Oxford,

"Many specimens look similar to each other and we have to use elaborate morphological features such as muscle orientation and gut length to differentiate between them."

So far, more than 70 species of squid have been identified from the Seamounts cruise, representing more than 20% of the global squid biodiversity.

Chuck Bone's picture

Sorry GS, I'm not buying it. This report is the crack dealer explaining to the taxpayer why the government crack addict needs to keep buying money/crack from them on the backs of its citizens.  The banks created this crisis through idiotic lending, moronic derivative creation and doing everything they could do generate more commissions and siphon more wealth from the general populace. QE/QE2/TARP, etc isn't intended on doing anything for the economy, the only purpose is to prevent/forestall the collapse of the big banks because they hold so much of that worthless MBS, but unlike the hedge funds and pensions that bought them they hold the special status of "bank" so their stability is "crucial" to the financial system at large and if they fail all is lost.

People always do what is best for themselves... and who is in charge of the central bank?  Oh that's right... partners of the big banks! This is nothing other than a way of just stealing wealth from the people to cover bad bets under the guise of helping them. There's a special place in hell for these charlatans.

buzzsaw99's picture

crack dealers and crack whores are legitimate business people, the squid is not. Comparing the two is an insult to the former group, not the latter.

Careless Whisper's picture

Q: How's that insider trading thing going for Goldman?

A: Matt Tabibi has something to say about that:


DisparityFlux's picture

Jan better keep his day job.

This rhetorical Q&A routine will never be popular on the vaudeville circuit.

Can he do this routine with a ventriloquist dummy or a pratfall clown?

DisparityFlux's picture


Let me guess.

Stan's playing Lloyd and Laurel's playing Ben.

Optimusprime's picture

That's Stan (Laurel) and Ollie (Hardy).  There--corrected for you.

Reese Bobby's picture

Goldman's money machine has been challenged.  They are betting this year's comp on a leveraged bet on a low vol scenario for MBS.  No fuckin worker bee/ecomonist will be allowed to screw with that. It is simple game theory: we are right, or I take my lack of morals somewhre else...

Bruce Krasting's picture

Jan missed the QE number by a mile. Why? The new wild-card in Fed policy is public opinion. From overseas finance ministers to the blogs. QE2 was D.O.A.

That wild-card is now a permanent card in the deck. The boys at Goldman, Ben Bernanke and the others at the Fed have to adjust to that reality.

I would score "1" for the blogs. Tks ZH.



DisparityFlux's picture


Isn't this just covering debt payments due now by pushing its complete repayment further into the future on the hope we will create wealth in order to afford paying the future debt or the debt becoming someone elses' loss?

And the debt payments made now are more affordable with reduced credit cost and favorable deficit accounting.

Its seems the modern monetary system is perpetual motion founded on obscuration and blind faith -- the currency portion being just a tedious artifact.

This I believe people can accept.  What most have problems with are the methods employed to create wealth, who are getting wealthy and at whose expense.

Downtoolong's picture

I believe Goldman's basic goal in the markets is to stir it up and keep everyone off balance as much as possible as often as possible. More uncertainty & change = more trading & transactions = more profits for Goldman. They have 1000 exotics ways to do it, but, the purpose is always the same. As long as they keep fanning the flames beneath everyone's feet, the markets will dance. 

bluprint's picture

The shift in the composition of the private sector’s asset holdings from longer-term Treasuries to cash should raise the price (lower the yield) of longer-term Treasuries.


If the private sector has less demand for treasuries, that should lower the price not raise it. Hello?